The markets are quivering like the proverbial aspen leaf. The mood amongst the business community -- despite its assertion on May 13 that reforms will go on no matter who forms the government at the Centre -- is one of trepidation.

Corporate India, the stock market, and foreign investors alike are holding their breath and keeping their fingers crossed over what will happen to the country's growth now.

The Congress and its allies are set form the new government, but a lot is dependent on the Left parties. Congress, as the harbinger of the Indian liberalisation process, has had a good track record on reforms but this time it has to depend on the Left parties to help it sail through. And this dependence raises questions about whether the Congress will be in a position to take tough economic measures.

Change in govt at a wrong time

From the business point of view, the change in government has come at the wrong time, says Smith Barney, a division of Citigroup Global Markets Inc.

With its strong economic fundamentals, India is on a high-growth trajectory. The reforms juggernaut has gained momentum, foreign investment has risen in the capital markets and the infrastructure sectors, companies are performing well, urban consumption is growing, services sectors are shining, outsourcing trends have been positive, and bilateral ties with Pakistan, China and the United States are better than ever. But if there are some major policy changes, inimical to the world of business -- like curb on foreign direct investment, privatization, etc, then economic growth could be severely retarded.

It is clear that the Left parties and the other allies of the Congress will exercise considerable influence on the Congress which can affect policy decisions.

With no significant reforms coming through, there is a fear that there might flight of foreign capital, affecting future growth, expansion, employment and prosperity.

Coalition pressures

For the markets, the worst has come true: a change in government accompanied by a big bag of uncertainties. With the Left parties opposing divestment even before a government is in place, the stock markets nose-dived by 330 points on Friday.

With the Congress's major allies -- Left parties in West Bengal and Kerala, Rashtriya Janata Dal in Bihar, and DMK in Tamil Nadu -- facing elections in their states within the next year or two, the party will feel pressures of keeping a coalition together.

Given their compulsions of keeping their constituencies happy, these parties are likely to oppose any bold economic measures and stymie all efforts at pushing through tough reforms.

The stock markets are already in a state of panic. On May 13, when it became evident that the Congress and its allies would be able to form a stable government at the Centre, the initial shivers died down: from having slipped by 200 points early in the day, the Sensex gained 41 points to close in the positive zone.

The market's initial reaction was of relief, but that comfort seems to have deserted it now. A stable government is one thing, taking tough decisions another, Smith Barney says.

Smith Barney foresees the nation a choppy ride on policy initiatives over the next 6 months to a year and has changed its outlook on the Indian markets to 'cautious.' It has also cut its target for the Sensex from 6600 to 5800 levels.

More populist measures?

UBS Investment Research says that the scope for populist policies has also increased substantially. UBS believes that reduction in subsidies or raising the tax effort (tax to GDP ratio) from the present level of 9.3 per cent of GDP now seems difficult.

The planned introduction of the value added tax 2 (VAT) that would have raised the tax to GDP ratio by 0.5 per cent is likely to take a backseat. Central government subsidies presently at 1.6 per cent of GDP could potentially increase, particularly as a weak government would be reluctant to raise subsidized kerosene and cooking gas prices.

The fiscal issue becomes even more important considering that the BJP administration had not put in any structural measures to consolidate the fiscal position, with the exception of deregulating oil prices.

Much of the improvement in the fiscal deficit during the BJP rein was in FY04, a period when there was a confluence of favourable factors such as low interest rates, strong growth and buoyant asset markets, says UBS.

Rural thrust

The NDA's brand of reforms focussed more on the urban areas: financial sector reforms, delicensing of industry, stock market regulation, divestment, containing fiscal deficit, etc, were more aimed at the urban areas. These measures did lead to some progress at rural level: easier imports of agricultural products; reduction in duties has facilitated lower input costs and allowing agri exports; e-choupals, rural roads and the second green revolution.

But the benefits did not rub off on to the poorest of the poor, the marginal farmers and a majority of the rural folk.

Reform issues that may face hurdles

Divestment: The privatisation process is likely to be quite difficult. The Left is against strategic sale route of privatisation, which results in transfer of majority stake and management control.

Subsidies: Fiscal deficit remains a thorny issue for the Indian economy, with combined state and central government deficits running at 10 per cent, says Smith Barney. Many of the subsidies are hurting earnings of key listed companies- notably the adverse impact of LPG/kerosene subsidies on the oil sector. Subsidies in other areas - food, power fertilizer - are also high. Expect no positive moves in these areas in the near term, says the Citigroup division.

Banking sector reforms: Reduction of government ownership in banks, increase in foreign limits in state-owned banks, promoting consolidation in the banking sector and higher FDI limits in financial services (especially insurance) could all be on the back burner.

Foreign direct investments: Plans for FDI limit increases may be hit. While not being against foreign investments in general, some of the Congress allies may be against increase in FDI limit in key sectors, including banks, insurance, retailing, telecom.

GDP growth may be hit: Smith Barney says that there is also a possibility that there may be even some about-face in policies. The merchant banker has thus lowered India's GDP estimate for fiscal year 2004-05 from 7 per cent to 6.6 per cent, and the rupee estimate from Rs 42.5 to Rs 43.50.

Momentum may be lost

Smith Barney says that the key growth drivers during the last 18 months have been retail lending and infrastructure spending. A change in government, it says, will impact the momentum seen during the last few months.

The reason being that a new government is likely to re-open all the projects initiated by the earlier one. Thus ongoing infrastructure projects, which so far have had a positive impact on cement, steel, construction equipment, may be delayed.

"There is a possibility that a change in government would impact some of the new growth drivers (capital expenditure recovery), which had just started kicking in. Corporates are likely to put their expansion plans on hold, until the new government settles down and comes out with their policies. Overall for FY05, growth could come in a bit lower at 6. 6 per cent instead of our estimate of 7 per cent," says Smith Barney.

Long-term positives

While in the immediate near term merchant bankers see policy inaction resulting in lower growth, in the medium-long term, they remain positive as India's fundamentals are strong.

Analysts feel that if Manmohan Singh and P Chidambram are assigned portfolios of, say, finance and commerce, the market participants' concerns will be substantially reduced.

Most uncertainties, however, produce opportunities, and it might be no different this time.